(Bloomberg) – During the recent government shutdown, US Commerce Secretary Wilbur Ross wondered aloud why financially troubled federal employees don’t just “get a loan.”
Ross, a wealthy private equity investor, faced annihilation. However, the underlying question remains even if a second shutdown is less likely. For Americans with limited options and desperate for cash, here are consumer lenders like Enova International Inc., Curo Group Holdings Corp. and Elevate Credit Inc. come into play.
They are part of a growing industry of online companies specializing in risky borrowers. For example, Enova offers loans with interest rates ranging from 34 to 450 percent, depending on the amount, due date, and creditworthiness of the borrower, according to their website. The expectation for the most expensive type of short term borrowing, the store front “payday loan”, is that you will pay it back when your paycheck is cashed. Still, one might wonder how such sky-high rates even exist.
“Not having access to credit is worse for consumers,” said Mary Jackson, executive director of the Online Lenders Alliance, a lobby group that represents fintech lenders. She said high-yield, high-risk loans had a well-known parallel – the bridging loan – that homebuyers sometimes use to close a deal. “Most of these loans would be considered bridging loans – for major car repairs and water leaks.”
And forget about the obvious Hollywood images that bring triple-digit rates to mind. The average customer is not an unemployed person. Recidivist gambler on his luck. According to Jackson, these are often college graduates in their thirties and in paid employment. However, regardless of a borrower’s background, critics warn that the price of such loans can get very high very quickly.
Approximately 12 million Americans use these high-interest loans each year both online and through approximately 16,000 business locations, said Alex Horowitz, a senior research fellow on the Pew Charitable Trust’s consumer finance project. According to a 2018 report by the Office of the Comptroller of the Currency (OCC), U.S. consumers borrow nearly $ 90 billion each year in the form of short-term small loans, typically between $ 300 and $ 5,000.
And the future looks even brighter. Just last week, the industry received a boost from Kathleen Kraninger, a budget clerk for the Trump administration who recently took over the U.S. Consumer Financial Protection Bureau. She proposed the abolition of an Obama-era requirement that would have come into effect Aug. 19 that would have forced payday lenders to assess a borrower’s ability to repay. Consumer advocates were outraged by Kraninger’s proposal.
“Both borrowers and responsible lenders would suffer if the CFPB finalized the proposal,” said Horowitz of Pew. The new rule would “eliminate balanced consumer protection and deregulate 400 percent interest loans given to millions of struggling Americans.”
Although the industry is largely state regulated – only 34 even allow payday loans – an attorney for some of the larger lenders warned that the Obama rule would wipe out a significant portion of the payday industry. Alan Kaplinsky, a partner at Ballard Spahr law firm, said the requirement that lenders ensure borrowers can repay “would have made it easier for offshore payday lenders to do business and charge consumers a lot more”.
But even with the CFPB proposal and a befriended U.S. government, some online lenders are moving away from payday loans. Many have chosen installment loans that are paid back over time rather than in a single payment. In addition, these lenders also offer so-called “credit lines”, which work in a similar way to credit cards.
Nevertheless, installment loans can also come with staggering interest rates. An example on the Enova website shows a $ 1,000 loan with 13 payments at an APR of 172.98 percent. In the end, this would take a total of $ 2,225.18 to pay off. Enova declined to comment.
The industry argues that high interest rates are needed to counter the risk that consumers are more likely to be given money. In a security filing last year, Chicago-based Enova set out how risky its business can be.
For the third quarter of 2018, the company forecast that nearly 33 percent of its outstanding “short-term loans” would never be paid back. The expected loss fell to around 19 percent and 13 percent for credit lines and installment loans. In connection with this, according to the Federal Reserve Bank of St. Louis, the banks recorded only a 3.5 percent loss in credit card loans in the same quarter.
While such exorbitant interest rates might be justified for lenders, Horowitz said the costs could be severe for borrowers.
“Right now, 80 percent of payday loans are taken out within two weeks of a previous payday loan because the loans averaged a third of the borrower’s next paycheck,” he said, a burden that can grow with each new loan. “The average payday loan customer pays $ 520 a year in fees to repeatedly borrow $ 325.”
While these lenders may have the upper hand in the short term, the days of super high yielding loans may be numbered. The payday loan industry emerged because traditional banks were reluctant to serve the low credit universe. This was partly because regulators didn’t give them clear guidelines. But that can change.
In 2017, another rule by the CFPB opened the door to banks and credit unions to offer small installment loans at reasonable prices. Last May, the OCC followed suit with guidelines for short-term installment loans in small dollars. In November, the Federal Deposit Insurance Corp. then issue a public statement on small dollar loan products.
Horowitz sees this development as a huge benefit for Americans who use payday products.
“Banks can be profitable at a cost six to eight times lower than the average payday loan price,” he said. For example, a payday borrower accumulates $ 350 in fees on a $ 400 loan in just over three months. At USBank, a similar loan that is offered to a similar customer costs only 48 US dollars as part of the new product “Simple Loan” launched in September.
“It’s a really good thing that some of the banks are getting into small dollar lending,” said Kaplinsky, the industry attorney. “That will create more competition and ultimately help lower interest rates for consumers.”